How to Spot the Bottom

Sam Stovall, Standard & Poor’s chief investment strategist, says historical data can help us see when the bear market might end. His verdict: Not yet, but maybe soon.

Investors are constantly asking, “When will this bear market end?” The only correct answer to that question is: “when stock prices stop falling.”

“In that case,” they frequently add, “I’ll just wait until the fundamentals start to improve before I get back into equities.”

While this mindset might serve them well in the near term, it might also cost them in the longer term. Since 1949, bear markets bottomed a median of five months before recessions have ended and eight months before corporate earnings hit a trough and unemployment peaked.

In the past 60 years, the beginning of a new bull market preceded the end of a recession by an average of four months (and a median of five months), and correctly anticipated the end of a recession nine out of ten times.

The Standard & Poor’s 500’s price performance foretold the recession’s demise fairly consistently, posting both a mean and median average advance of six months. Only during the bear market of 2000 to 2002 did the S&P 500 remain in bear market mode well after the economy began to recover.

Since 1988, year-over-year declines in corporate profits bottomed an average of five months (and a median of eight months) after the bear market ended.

A peak in the unemployment rate traditionally lagged the end of a bear market by an average of nine months (and a median of eight). The unemployment rate averaged 8% at its peak, ranging from a low of 6.1% in 1953 and 1970 to a high of 10.8% in 1982.

As a result of this analysis, it seems curious that investors talk about waiting until the fundamental data begin to improve before moving back into stocks. The market frequently has a mind of its own and will likely bottom when it believes the rate of decline for gross domestic product (GDP) and corporate earnings will likely slow, not when they turn positive.

S&P’s Economics forecasts the current recession to end in the summer. S&P’s equity analysts project operating results will hit a nadir by mid-2009, and S&P Economics thinks earnings growth will bottom in the third quarter.

Therefore, we see earnings recovering from zero to three months after the end of the recession, which would be similar to three prior recessions, but a bit shorter than the historical average.

S&P also projects the unemployment rate will peak in early 2010 at an average 9.35% for the first quarter. This peak will likely come about six months after the recession ends, which is a bit longer than all recessions, but consistent with sluggish recoveries.

So, when do we think prices will stop falling? Mark Arbeter, S&P’s chief technical strategist, recently wrote: “We will see another leg lower [for the S&P 500] that eclipses the bear market lows.” Most likely, he believes the S&P 500 will ultimately bottom in the 625 to 675 range some time in the second quarter. (It hit 666.79 on March 6th—Editor.)